Description

Business Overview

Thor is the world’s largest Recreational Vehicle (here-in after referred to as RVs) manufacturer in the world. RVs are a type of vehicle (with/without an engine) that include living quarters designed for accomodation. While RVs can be used for a number of different purposes, camping is the top one. RVs come in two types – Towables and Motorhomes. Former is a type of trailer truck which one can tow to their light vehicle while Motorhome has a engine of its own so one can drive that around directly. Thor reports on July ending fiscal year.

As Thor operates in a two key geographies – North America (NAM) and Europe, it is worth noting the differences between the two. While NAM is majorly a Towables market (~90% share by volume), Europe is a Motorhomes market (~70%). Cost of a Towable is only ~30% of that of a Motorhome. The European business is not central to this investment idea so it will have less focus but I will talk about it as how Thor has managed to hit a home-run there. To set context, Thor’s North America business contributed around ~70% of EBITA in 2023 and Europe is the rest. Within NAM, there is a small piece of business which sells parts to other OEMs and in the aftermarket and while Thor thinks they can do wonders in the aftermarket business, at this point, it is too small to make an impact even if they double that business in the next two years so we don’t need to discuss it too much.

Thor operates multiple brands in both the geographies and its brands even compete with each other. From its investor day in 2022, Thor has 16 manufacturing companies which represent 140+ brands. It is a decentralized model that the company runs. Thor does say that they do drive efficiencies by the weight of their combined share in the market but we have no way to verify except trust the management.

Thor has about ~40% market share by volume in North America and ~27% in Europe. It is imperative to note that Thor has grown through acquisitions in its history and is quite adept at integrating companies. Out of the roughly ~4 bn in free cash flow that Thor generated in the last ten years, ~90% of it went towards acquisitions, though not all were entirely internally funded but one gets the gist.

In my opinion, there are two very important things to note about the RV industry. One, it is a consumer discretionary item and it is a highly cyclical one (which is exactly why I am submitting this as a investment idea) – Peak-to-troughs on volumes can be tough based on differing macro-economic situations but based on past data from 1980s, we have seven peaks and troughs and while the numbers would say the average trough is 27% from the peak, GFC was in particular pretty worse with volumes down ~58% and 2023 coming next with ~48%. Two, it is a highly variable cost structure business. If you’re thinking of RVs as just another Automobile manufacturer, there would be nothing further from the truth. RV manufacturing sites are not fancy in terms of automation at all. In fact, they are highly labor intensive. I would like to think this is mainly because of the cyclical characteristic of the business. I will come to this variable cost structure point later in this idea and delve deeper on it however it would be fair to mention that this variable cost structure applies more to their North America business than Europe.

Is it a growth industry? Well, that is a tricky one. We have data going back to the 1980s for North America, and it would seem that RV volumes grew at low-single digit (2-3%). It would be naïve to only look at past 10 years of data which would give you a different perspective that RVs show are a mid-single digit level of growth. Another interesting way to look at the volumes is by looking at in terms of penetration as % of households. For simplicity’s sake, I am comparing the NAM volumes against US households only. Household penetration of RVs has increased from ~20 bps (RV volume shipments in a year/No. of US households) in the 1980s to ~27-28 bps in the early 2000s to ~33 bps in the pre-covid years.

What about competition? As earlier mentioned, Thor has about ~40% market share in North America while Berkshire Hathway owned Forest River has about ~35% market share. We know nothing about Forest River’s operations or profitability. Winnebago Industries (NYSE:WGO) has another ~12% market share and the rest is spread out. On the European side, French listed Trigano is the market leader with ~30% share while Thor owned EHG brand has ~27%. There are a few other companies in Europe which have a high single digit share as well. That being said, RVs are certainly a low barrier to entry kind of industry as RV manufacturing facilities are not capital intensive.

Is it capex heavy? Absolutely not. Capex as % of Revenues hover around ~1.5% levels only. Moreover, it is highly flexible. 2009 saw Thor’s capex at only ~6 mn vs ~46 mn in 2005.

What about returns? High returns. In fact, everyone in the value chain of RVs seems to make good returns. Last 10 years average pre-tax RoICs for Thor would be ~27% compared to Winnebago’s ~24%. LCI Industries and Patrick Industries, components provider to RVs (and Marine) had the same as ~23% and ~20%. Camping world holdings, a dealer for RVs generated ~23%. One of the reasons why Thor’s ROEs have been lower than that of Winnebago in the past (~19% vs ~22%) mainly due to leverage.

Misc - Thor’s book value has grown at a CAGR of ~16% in the last 10 years and ~12% in the last 20 years. Thor has about ~450 mn share repurchase authorization while trailing twelve months share repurchase amount would be ~47 mn.

The Investment Idea

To understand the idea, we need to go back to the covid times. Remember, when you weren’t allowed to travel because the person sitting next to you on the flight could give you this virus called covid-19? Well, the fear of covid certainly drove people to try out different things. We saw many behavioural changes in people. Covid left people very little things to do from a leisure standpoint. RVs are primarily used in camping and one could easily go on a camping trip (than to Disneyland) during covid and it was a safe enough exercise as well. Hence, there was a huge craze for RVs. 2021 saw ~600k in RV volume shipments vs an average of ~464k in 2017-19. 2022 saw a reduction but was still considerably higher at ~493k shipments. As covid worn its effect out and people started to travel, RV shipments dropped materially in 2023 to ~314k. Higher interest rates also weighed on RV purchases as ~50% of the buys are on financing basis in North America (only ~20% in Europe). They key thing to understand here is that there was obviously some excess buying that happened in 2021 and 2022 which had its effect on 2023.

Such a sharp decline in volumes could lead to one thinking that OEMs like Thor would have suffered in a disastrous manner. Well, they did suffer but not nearly as much as one would have expected. Thor’s gross margin for North America Towables in 2021 and 2022 were ~17% and while for 2023, which saw volumes down ~43% yoy, it was ~12%. This wasn’t an aberration. In 2006 (peak before the GFC), the same was ~16% and in 2009, volumes down 61% vs 2006, it was ~12%. The same happened even in 2019 when there was a less severe downcycle but gross margin deterioration was hardly anything that to the naked eye it would seem as if everything is alright in the business. This is also visible through Thor’s employee count in the US which is around ~30k but only 10% of them are on a salaried basis. Thor’s lease costs (can be considered fixed costs) were only 27 bps of total revenue in 2023, which is actually a downcycle year.  

This is exactly the beauty of this business model. Now, if this were any other automobile manufacturer like Ford, GM, Tesla, etc. there is no way gross margins hold at this level after such a decline in volumes. There is a flip side to it as well, that margins do not go up in a upcycle but that’s acceptable.

Essentially, Thor did about ~328k shipments (NAM+Europe) in 2022 and only ~187k in 2023. In the most immediate pre-covid year 2019, Thor would have done ~240k on a pro-forma basis as Europe was acquired during the year.

Hence, the business is significantly distressed as of today. On an earnings per share basis, Thor did $20.6 in 2022 and only $7 in 2023. But even in the most severe year, Thor has been profitable, both from an earnings as well as cashflow standpoint. In fact, Thor’s past 20 years have been free cash flow positive! It didn’t lose money even in 2009.

On a trailing twelve month basis, Thor generated ~550 mn of free cash flow against ~4.8 bn in M.cap. Working capital is favorable in a downcycle for the industry as inventories run down. In addition, Thor has ~130 mn of amortization of intangible assets (acquisition related) that depresses its earnings but doesn't impact cash flow. It also provides a tax shield on PnL. Hence, cashflow will be better than earnings.

Where do we go from here? Taking the expectation of RVIA (Industry association for RVs in North America) for 2024, we would have about ~440k shipments a year on average from 2021-24. The same for 2016-19 (immediate 4 year period pre-covid) was ~456k shipments. Why have I chosen 4 years? No particular reason except just to look at volatile yearly numbers on a smoothened basis. One could consider 5 or 6 years as well but the overall conclusion would not drastically change. The point is that the excess of 2021 and 2022 would have been worked out by end of 2024 and given RVIA’s low end of guide for 2024 is ~6% above 2023, a trough has likely been made in 2023. And with interest rates likely to move one notch below than up, it would seem as if RV shipments should only go up from here. Recent monthly data also suggests the same thing – November’23 to March’24 yoy volume growth rates were 2.9%/8.1%/13.6%/17.8%/1.2%. The lower March number is concerning but expecting linearity in the recovery of volumes would be naïve in the first place.

Another aspect of the decline in current volumes is due to ASP being negative on yoy basis (more of decontenting along with some commodity deflation and supply chain loosening) and hence there are a few earlier models of higher ASPs still lying on dealer lots left to be sold. Towable ASP was down 20% yoy in Q2’24 for Thor. As they work through the older inventory, it could weigh in on margins in the near term.

To think about how a normalized volume level would look like, I take the ~2017-19 average (of retail shipments) of ~475k and assuming growth would be ~1% a year (higher than US household formation growth of ~60-70 bps a year), we would have ~514k shipments in 2027. In its Investory day in 2022, Thor has suggested North America would have ~585k-610k shipments a year in 2027. One of the reasons why Thor has a higher number is they are assuming that people who tried camping in covid will stick around and there will be some incremental demand just because of that. Data from Kamping Grounds of America suggest that households who camped for the first time increased from a typical ~2 mn a year average pre-covid to 10/9 mn in 2021 and 2022. In fact, their data suggests Annual active camper households increased from ~33% of total US households in 2019 to ~45% in 2022. In 2015, the number was ~28%, so clearly the increase we saw in covid was of a much higher level than in the pre-covid years. Now, some data already suggests that we have lost quite a bit of those temporary covid workers and hence, I don’t include any such incremental benefit from the covid related camping activity when I think about 2027.

I will also address the doubt that some could have around camping. It is an old people’s activity and the young generation doesn’t like it. Again, data tells otherwise. Gen Z made up ~25% of overall campers in 2022 vs ~30% that they represent from a population basis.

One of the other things that poses well for the North America RV industry is the increasing mix of light trucks as opposed to passenger vehicles. In the mid-2000s, light trucks and passenger vehicles represented an equal share of the total light vehicles in US. However, last few years have seen the ratio move in favor of light trucks (trend towards SUV) with the mix % being ~70% and above for light trucks. Remember that Towables are the dominant form of RVs in North America and you can’t exactly use a sedan to tow a towable RV. Light trucks like SUVs are much better suited.

I take 2027 as the year of valuation since it would certainly take a while to increase volume from the current levels. Even after the trough in 2009, it was only in 2016 that we crossed the prior peak volumes of 2006, so it is best to remain prudent.

Before I get to the profitability aspect and EPS calculations, I wanted to talk about the European business and the kind of value that Thor’s management has generated for its shareholders. Thor acquired the European business in 2019 for ~1.7 bn USD and funded it entirely with debt. Thor had zero gross debt at the time. Hence, we know that all the interest expense that Thor reports, we can entirely attribute it to their European business. It didn’t perform quite well in the beginning as Thor was still integrating it and it was their first time stepping outside of North America so fair to assume execution would have been slower. In fact, covid hit immediately within a year after acquiring that business and hence, the integration plans got derailed further. But, Thor has done an incredible job in the past year or so. European business did 2.6% in EBITA in 2020 while the same was 5.6%/5%/7.7% in 2021/2022/2023. In fact, Thor had a target gross margin of ~15.8% in 2027 from its investor day in 2022, and in 2023, Thor managed to clock 16.6%. Now, part of this is due to the shortage of chassis in Europe (RV manufacturers typically source chassis from Auto OEMs like Ford, Mercedes, etc.) which resulted in lower RVs available as well. Still, Thor has managed to do quite well in executing its playbook on the European business. It did about $180 mn in PBT for 2023 (after interest expense of $100) and assuming ~25% tax rate, Thor’s shareholders have been rewarded ~140 mn in net income ($2.75 in EPS) for absolutely free of cost. Why so? Because the entire cost was absorbed in the ~100 mn interest expense and the entire acquisition was funded with debt and zero internal accruals! Some may think this could have been risky but since this business is very capital light, acquiring companies for debt and improving their business fundamentals is an excellent way to generate shareholder value. In the past, Thor has only had debt when it went to acquire something.

From a profitability perspective, Thor did an overall operating margin 7.4/9.4/5.3% in 2021/2022/23. Historical numbers should be a good benchmark here although I believe that Thor’s margins in a non-acquisitive future would look somewhat higher than just taking an average of the past few years. I say that because from slide number 24 in its Investor day 2022, we clearly know that the companies that Thor acquired over the years had a lower profit margin at the time of acquisition vs in the years after operating under Thor. I do accept taking an average is a lazy way to do it but given the less volatility in the business and the variable cost structure model, it should be a reasonable way to do it – From 2010 to 2019, the average operating margin was 6.9% while the range was 5.4%-8.6%. Hence, while I assume a ~7% operating margin in 2027, I do think that if Thor doesn’t acquire anything that dampens its margins, the margin will be closer to ~8%. To drive home this point, Thor acquired a brand called Jayco in 2016 and operating margin in 2017 fell to 7.7% from 8.6% in 2016; Jayco had contributed ~25% of 2017 revenues.

To get to 2027 EPS, we have volumes and we have operating profit margins. I didn’t talk about ASPs but I am not doing anything creative on that, just taking it on an inflationary basis, as has been the case historically. Based on a ~2-3 years of higher inflation and others at ~2% we get to a ~3.5% annualized CAGR from 2019 basis. As a result, we have ~282k in total volumes for Thor in 2027 compared to ~240k pro-forma in 2019 and ~328k in 2022. We get to ~14.6 bn in Revenues and compare this to Thor’s Investor day target of ~20 bn in Revenue, we are well short. At ~7% operating margins, we would get ~1 bn in Operating profits and assuming similar interest expense as in 2023 and ~25% tax rate, we would have ~680 mn in net income or ~12.7 in EPS.

Thor’s Forward P/E has been in the band of ~11-15x and assuming it at the mid-point of ~13x we would have $165 as target price. Compared to 5/5/24 share price of ~$100, that would be a ~65% return over two years (July 2026 since we are assuming forward P/E for 2027 EPS). Even if it takes a year later to get to our target price, the annualized CAGR would still be in high teens. Thor does pay a dividend of ~$1.8 a year (~2% dividend yield). It could certainly create some good value by accelerating the pedal on its share repurchase program at current prices. Thor’s Investor day suggests an EPS of $27 in 2027 and so at ~13x P/E, that would indicate a target price of $351, a far cry from today’s $100.

Risks/Concerns

Market share – Thor’s market share in North America in volume terms has come down from ~51% in 2017-18 to ~40% in 2023. They have lost more market share in Towables as opposed to Motorhomes and so on a $ value basis, the market share loss would have been closer to ~5-6 percentage points instead of the 11 (51-40). One of the reasons for this increased market loss is there was a new brand called Grand Design which was built by The Fenech brothers who had earlier built a different brand, which Thor had acquired. Grand Design was acquired by Winnebago. The point to make here is that new brands can make a dent in the industry.

Interest rates – Given ~80% of RV purchases in North America on financing basis, higher interest rates obviously pinch the volumes to a great extent. Hence, if rate cuts get delayed, that could certainly delay the volume recovery.

Slowdown in Europe – Right now, Europe is functioning pretty well and although Thor’s Europe business does not seem to generate margins like Trigano (French listed largest player in Europe), any slowdown in volumes in Europe could create further stress in their European business. I am less worried about a material decline in volumes in Europe because of no real pent-up volumes in 2021/22.

Inventory days – Thor’s Inventory days have shot up from mid 20s pre-covid to 64 in 2023. One of the reasons that Thor cites is that due to difficulties in chassis availability during post-covid times, they are hoarding more of those today than before and the situation may resolve itself sooner. Chassis inventory as proportion of total inventory increased from ~20% in 2019 to ~38% in 2023. However, even if exclude chassis inventory, days would still be materially higher than the pre-covid average. Inventory did reduce on $ basis in 2023 and hence I think the higher days is simply because of the low year that 2023 was. However, structurally higher inventory days could mean increased capital intensity in the business.

Valuation – Thor’s highest share price date was in 2018 at ~$156 while in the post-covid boom, the highest share price registered was only $140. However, EPS in 2018 was $8 vs $20 in 2022. Hence, in spite of the 1.5x higher EPS, highest share price was lower which could simply mean people are becoming more thoughtful about the cyclical element of this business.

Interest in RVs – People could simply be less interested in RVs.

Catalyst

Interest rate cuts 

Fuel price going down, increasing disposable income